Educational Articles

Why have lumber prices rebounded strongly?

Dominic B. Silva
| May 22, 2011

Lumber prices have historically been correlated to the overall health of the U.S. home construction sector. Recently, however, North American lumber fundamentals have firmed despite weakness in build rates. Indeed, since falling from $440 per thousand board feet (mbf) in 2005 to $140 mbf in early 2010, lumber prices have since rebounded, and now approximate $235 mbf. This disconnect is owed to a number of global factors.

In 2008, Russia started to tax timber exports aggressively, clouding relations with its biggest trading partner, China. Note that the availability of logs is pivotal to lumber markets. This encouraged the world’s most populous country to buy the product from other markets. With the number of countries capable of supplying massive quantities of timber limited, Chinese companies shifted their voracious appetite towards North America. Due to supply constraints in Canada (see below), lumber producers in the United States are benefiting. After doubling in 2010, lumber exports from the United States should continue to advance in the years ahead.

While North America is experiencing higher demand from overseas, its supply is falling. A massive pine beetle infestation is destroying timberlands in the Canadian province of British Columbia, which accounts for approximately one-third of the lumber used in U.S housing markets. All told, the infestation has destroyed much of the timber occupying more than eight million acres of land. Moreover, supplies from British Columbia are not likely to rebound to normal levels for several decades.

Another reason for the aforementioned disconnect is a decline in inventory. Since the U.S. home construction market started showing signs of weakness in 2006, timber companies have substantially curtailed harvesting levels. This, combined with the fact that inventories have been drawn down, is enabling a marginal improvement in demand to boost prices sharply.

Meantime, catastrophic events in Japan have resulted in the destruction of more than 140,000 buildings, with thousands more damaged. Once safety has been assured at the Fukushima nuclear plant, a massive reconstruction effort is likely to commence. This augurs well for timber and lumber producers, since wood will likely be the preferred choice for most residential housing. Japan typically deals with a high number of tremors each year, and wood is relatively more effective in withstanding earthquakes. Weyerhaeuser (WY) should benefit from rebuilding activities through long-established business partnerships. Too, this industrial Real Estate Investment Trust has timberland holdings on the U.S. western coastline, making shipments relatively quick and cost effective.

The confluence of these factors suggests lumber prices should forge ahead during the upcoming years. According to industry insiders, the value of this commodity may well approximate $500 mbf in the next five years. Such a sharp run-up would benefit other enterprises, including Rayonier (RYN). This Florida-based company produces and sells logs, timber, and wood products, and is a leading manufacturer of high-value specialty pulps. Rayonier holds numerous parcels of land in the eastern and western United States, including areas close to shipping ports.

Fundamentals in the timber/lumber markets also should lift Potlatch (PCH), a REIT with roughly 1.5 million acres of timberlands, mostly in the mid-western United States. Its primary activity is the management of timberlands in order to improve long-term sustainable yields. The real estate recession caused Potlatch to defer harvests, which hurt results. But, with timber volumes growing, the company should begin to realize this value in the years ahead. Although this REIT does not sell directly to Asian markets, rising demand from Far-Eastern countries affects supply and demand in the markets it participates in.

The aforementioned factors should strengthen conditions in the North American timber markets, boosting lumber prices, and enabling the aforementioned REITs to register healthy growth.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.